Time Value of Money

Chapter 5: Time Value of Money

Multiple Choice Questions

Section 5.1 – Opportunity Cost

1. Charles has $12,000 to invest. Charles’ bank offers him the following savings accounts:

|Account |Interest rate |Minimum balance |

|#1 |1% |$0 |

|#2 |3% |$5,000 |

|#3 |5% |$10,000 |

|#4 |8% |$20,000 |

Assuming that all the accounts have the same risk as the investment, Charles’ opportunity cost is closest to:

A. 1%

B. 3%

C. 5%

D. 8%

Answer: C Type: Easy, Concept

2. If Frank is indifferent between receiving $1,000 today and $1,200 in one year, his opportunity cost must be close to:

A. 1.20%

B. 20%

C. 120%

D. 200%

Answer: B Type: Easy, Concept

Section 5.2 – Simple Interest

3. Earl has invested $12,000 in a security that pays 4% annual simple interest. How much interest does he earn in the 3rd year?

A. $160

B. $480

C. $1,440

D. $1,498.37

Answer: B Type: Easy, Calculation

Explanation:

A. 480/3 = $160

B. 12000*.04 = $480

C. 480*3 = $1,440

D. [pic]

Section 5.3 – Compound Interest

4. Consider two investments: XPD and PDQ. Each investment pays interest at the end of each year and the interest rate does not change over time. The interest earned each year is given below:

|YEAR |PDQ |XPD |

|1 |100 |50.00 |

|2 |100 |52.50 |

|3 |100 |55.13 |

|4 |100 |57.88 |

Which of the following statements is (are) most correct?

A. PDQ and XPD earn simple interest

B. PDQ earns simple interest, XPD earns compound interest

C. PDQ earns compound interest, XPD earns...